Cree's Flawed Double-Bottom Pattern Spelled Doom

It takes a keen eye to discern a properly formed base from a flawed pattern that ultimately ends up crumbling.

Honing your ability to spot flaws in a base can mean the difference between making a nice profit or being forced to bail out when the stock triggers the 8% sell rule. Of course, not all properly shaped bases produce winners, but poorly formed bases have little chance of success.

In this column, we'll focus on flawed double-bottom bases, which form over at least seven weeks and look like a "W." A common fault occurs when the second bottom fails to undercut the first on an intraday basis. In other cases, the middle peak of the W falls in the lower half of the base. An unusually deep correction, such as 50% from peak to trough, is another fatal chart flaw.

At other times, investors may see a double bottom when it's actually a triple bottom, which is a sign of wide-and-loose action and not of a proper base.

Let's look at Cree (CREE), a maker of LED lighting, components and semiconductor products for power and radio-frequency applications. The stock formed a double-bottom-like pattern starting in late April 2010.

On the surface, Cree looked attractive. Profit growth from the final quarter of 2009 through the first two quarters of 2010 was exceptionally strong, jumping 90%, 262% and 206% as the pattern was forming. Sales growth was robust and accelerating over that span, rising 35%, 78% and 79%.

But Cree's chart began to show flaws as the market slipped into a correction in early May. Few stocks, no matter how strong, can buck a market downtrend.

The pattern shows a series of wide and loose weekly swings of 10% or more as the stock fell to its first low. In a normal base, the initial decline is orderly and controlled, indicating that institutional investors are supporting the stock and gradually building a position on expectation of a rebound.

Cree bounced back sharply in the week ended May 14 to form the pattern's middle peak, (1) then retreated to form the second bottom of the W-shaped pattern.

However, instead of rebounding back toward the buy point, 10 cents above the middle peak high of 79.14, Cree lingered near the second low for several weeks 2. In fact, it undercut the low a couple of times, resulting in a sloppy, asymmetrical pattern. The stock also spent most of its time in the lower half of the base, another flaw.

Cree eventually tried to make its way back to the buy point in early July as the market uptrend resumed. But the stock never sustained the series of high-volume gains that would have indicated it had the institutional support necessary to break out to new highs.

Cree rolled over even as the market continued to rise. It hit a low of 47.30 in the week ended Sept. 10, 43% off its 83.38 peak.

It takes a keen eye to discern a properly formed base from a flawed pattern that ultimately ends up crumbling.

Honing your ability to spot flaws in a base can mean the difference between making a nice profit or being forced to bail out when the stock triggers the 8% sell rule. Of course, not all properly shaped bases produce winners, but poorly formed bases have little chance of success.

In this column, we'll focus on flawed double-bottom bases, which form over at least seven weeks and look like a "W." A common fault occurs when the second bottom fails to undercut the first on an intraday basis. In other cases, the middle peak of the W falls in the lower half of the base. An unusually deep correction, such as 50% from peak to trough, is another fatal chart flaw.

At other times, investors may see a double bottom when it's actually a triple bottom, which is a sign of wide-and-loose action and not of a proper base.

Let's look at Cree (CREE), a maker of LED lighting, components and semiconductor products for power and radio-frequency applications. The stock formed a double-bottom-like pattern starting in late April 2010.

On the surface, Cree looked attractive. Profit growth from the final quarter of 2009 through the first two quarters of 2010 was exceptionally strong, jumping 90%, 262% and 206% as the pattern was forming. Sales growth was robust and accelerating over that span, rising 35%, 78% and 79%.

But Cree's chart began to show flaws as the market slipped into a correction in early May. Few stocks, no matter how strong, can buck a market downtrend.

The pattern shows a series of wide and loose weekly swings of 10% or more as the stock fell to its first low. In a normal base, the initial decline is orderly and controlled, indicating that institutional investors are supporting the stock and gradually building a position on expectation of a rebound.

Cree bounced back sharply in the week ended May 14 to form the pattern's middle peak, (1) then retreated to form the second bottom of the W-shaped pattern.

However, instead of rebounding back toward the buy point, 10 cents above the middle peak high of 79.14, Cree lingered near the second low for several weeks 2. In fact, it undercut the low a couple of times, resulting in a sloppy, asymmetrical pattern. The stock also spent most of its time in the lower half of the base, another flaw.

Cree eventually tried to make its way back to the buy point in early July as the market uptrend resumed. But the stock never sustained the series of high-volume gains that would have indicated it had the institutional support necessary to break out to new highs.

Cree rolled over even as the market continued to rise. It hit a low of 47.30 in the week ended Sept. 10, 43% off its 83.38 peak.

See Also

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Most stocks will form bases during market declines, and the way the market corrects has a lot to do with how those bases will end up shaping. Take a modest market correction, and most bases from that period will be flat bases. Take a full-fledged bear market, and expect to find a lot of deep, ...

01/16/2015 02:49 PM ET

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